Export Flexibility and Hedging

Abstract

The paper considers a risk-averse international firm which sells its output in either the domestic or the foreign market. The firm possesses export flexibility, and so it can choose between the domestic and export markets after considering the foreign exchange rate. It is shown that a separation property holds if the proper hedging instrument is used: the firm's production depends on market prices and technology and does not depend on its attitude towards risk nor on its expectations. A full-hedge proposition is derived.

Restricted Export Flexibility and Risk Management with Options and Futures

“…Thus, models in which an exporting firm relies exclusively on currency futures or exclusively on currency options might seem unsatisfactory. Our model extends the work of Broll and Wahl (1997) in a way that provides a rationale for the joint use of currency futures and options. This is done by restricting the firm's export flexibility.…”

“…This is due to the fact that marginal revenue with respect to the exchange rate is independent of the restrictions. That is why Broll and Wahl (1997) derive an equivalent result for a fully flexible firm. In contrast to the production decision, the optimal hedge portfolio, (H * , Z * ), depends on the restrictions as will become clear later.…”

“…Broll and Wahl (1997) have shown that full hedging with call options eliminates exchange rate risk. This is due to the fact that revenue is piecewise linear in the exchange rate with a zero slope for low exchange rate realizations.…”

“…This approach, originally proposed by Ware and Winter (1988), has been further developed by Broll and Wahl (1997) in a rigorous formal model.…”

Forward Markets and the Behaviour of the Competitive Firm with Production Flexibility

“…In the context of export flexibility and currency forward markets, Eldor and Zilcha (1987) and Wong (2001Wong ( , 2002 examine the interplay between real and financial hedging and show the optimality of an under hedge. Should the exporting firm be competitive, Broll and Wahl (1997) show how the firm can completely eliminate its exchange rate risk exposure by writing currency call options.…”